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It’s safe to say no one in their right mind would ask to be audited.

The term “audit” generally strikes fear in most of us, as it’s associated with bad behavior and negative consequences. The IRS audits and then penalizes taxpayers. Companies fail SEC audits, and stock shares plummet. Politicians resign in disgrace when corruption is discovered.

However, the above examples are called “external audits,” which are examinations conducted by outside parties that are often involuntary. There are also “internal audits” conducted voluntarily by business owners and management that we should not fear.

Internal audits, also called performance or operational audits, refer to examining a company’s processes to assess whether the entity is achieving economy, efficiency, and effectiveness in employing available resources.

Why companies need a performance audit

A performance audit can help you figure out why something in your business is not working quite right or if it can be improved.

Conducting routine performance audits on your business, even a small business, can help increase sales and productivity, improve employee morale, and decrease costs. It is unfortunate that information on how to conduct do-it-yourself performance audits is not more widely available to business owners. Here is a brief and simplified how-to introduction to self-auditing your company.

If you are a business owner, you probably instinctively know where problems are within your organization. Is one department holding up the whole operation? Are low sales in one area causing your bottom line to suffer? Are some of your vendors overcharging?

So, how do you quantify the issue? How do you correct the problem? The first step to your do-it-yourself audit is to jot down those issues already of concern. One tip is to make a file folder (paper or electronic) for each problem.

Pick one issue at a time. Ask yourself,  how should the issue be handled if the company was operating optimally? How is it being handled right now? What changes need to be made to resolve the issue or improve? Now, the most challenging part for business owners, write it down!

For example, imagine your problem is the high cost of materials, and the objective is paying as little as possible. Optimally, your purchasing manager should obtain estimates from vendors for purchases exceeding a dollar amount you specify. They should also be comparing vendor prices quarterly or annually for smaller purchases.

If these steps are not in place or are not being followed, you would instruct the manager to do so and have them document and report to you the results. You can compare cost reports in the future to determine how much savings resulted from implementing these procedures.

Find the evidence

All audits require what is called evidentiary matter. Essentially, you want to gather relevant information to solve the issue. Without collecting and reviewing the data, you are just guessing.

In the case of the cost of materials, you could examine historical reports for trends. You could also pick a small sample of purchases and compare the prices you are paying with the prices of other vendors. If the issue involves sales or customer service, you may want to do customer surveys. If the problem involves employees or internal processes, interviews and surveys of employees might be relevant. Just like if you were an external auditor, document all of your evidence in your file folders.

The three E’s

As you perform your audit, you can better identify the issue you are looking at with the three “E’s”-

—  Economy- Is the issue that your resources are not available in the correct quantity, quality, time, and place at the lowest cost? Resources could include inputs like materials, labor, or marketing services.

—  Effectiveness- Is your management or staff not achieving operational goals? Are your goals and objectives clear? Have your goals kept pace with the current environment, or are you doing things “the way they always have been done?”

— Efficiency- Have you optimized how you use human, financial, and other resources to produce goods and services? Are you utilizing office space and machinery to its capacity? Is there conflict because departments or managers are overstepping the authority of each other, making your operations inefficient?

Business cycles

As you gain some confidence tackling individual issues, learn to look at your business as cycles that illustrate the flow or steps of how your company operates.

For instance, the sales cycle is your company’s process when selling a product or service to a customer. You can categorize all actions in the cycle into steps like prospecting, connecting, presenting, and closing customers.

The production cycle is comprised of all activities related to the conversion of raw materials into finished goods. The cycle includes the design of products, the production schedule, manufacturing activities, and cost accounting feedback.

It is helpful to draw a chart to visually examine all the steps in a cycle. There are many examples of flowcharts on Google Images, and there are also several free mind map programs with online templates to help visually organize and examine your business processes. By learning to map your operations, you will be better able to see the bottlenecks, duplications, and inefficiencies.

If you need additional help with starting the performance audit process, reach out to your accountant. Most CPAs have at least two years of audit experience. There are also highly qualified business consultants who understand the nuts and bolts of how to increase performance. Remember to document the decisions you make. Later, you will be happy you made a file.

Although auditing may be considered a dirty word, intuitively, we sense that accountability, which is an obligation or willingness to accept responsibility or to account for one’s actions, is a good thing that leads to increased results and better performance. An internal audit is really just making your business accountable to you and all of those involved.

Michelle C. Herting, CPA, ABV, AEP, specializes in tax planning, trust administrations, and business valuations. She has three offices in Southern California.